Skip MIPs in a falling market

SMART INVESTING

While monthly income plans (MIPs) have been among the most preferred investment options for risk-averse investor for most of last year, the recent market crash should force the investor to do a rethink on the strategy.

While last year's success story was of equity funds, MIPs also rode on the equity bandwagon to give encouraging returns even to those who are not so much enamoured by the equity wonderland.

These funds usually have an exposure of 80-85 per cent in debt and money market instruments and the remaining 10-15 per cent in equities and cash.

The point is that leading MIP schemes have managed to give returns in the region of 20 per cent, well above that of pure debt funds, the preferred haven for risk-averse investors.

The higher returns have meant that investors have also taken a beeline for these funds. Mutual funds themselves were quick to pounce on the opportunity, with nearly every fund launching a monthly income plan in the past few months.

Fund managers loathe to miss out on the equity growth story have also been increasing their exposure to that segment, which has resulted in higher returns.

Simply put, the higher MIP fund returns seen past year has been mainly driven by the equity component. But, there is another side to the story "" when the equity story takes a U-turn, your returns could also see a similar drop. In other words, there is no such thing as a risk-free MIP.

Take for example, a MIP having a debt exposure of 80 per cent and an equity portfolio of 20 per cent with an NAV of Rs 10. Assuming a principle return on your debt portfolio at five per cent, even a 20 per cent drop on the equity side is enough to bring your returns to zilch.

By the same token, a 25 per cent drop in equities can make your returns wander into the negative territory.

Now consider the case of an MIP with just 10 per cent exposure to equities. Even a 10 per cent erosion in the equity holdings of such a scheme can wipe as much as 1 percentage point off its returns.

In a world where debt ruled, when annualised returns of 12-14 per cent where commonplace, that might have been a small thing. But not any more, when debt fund returns are nearly half of those heady days.

While these are hypothetical case, it is not entirely inconceivable, given the volatile nature of equity markets.

While historically MIPs have proved to be a good investment option, there is a growing concern that investors have only seen the brighter side of MIPs.

Interest rates have seen steady declines for the past few years, which meant that debt funds and MIPs reaped a rich harvest. Falling yields drove debt fund returns in a falling interest rate scenario, as older papers carrying higher coupon yield became more attractive.

As the interest rates went on a downward spiral, debt funds managed exceptional returns as they gained due to capital appreciation because of higher prices of the long tenure bonds. However, with the yields having bottomed out and interest rates at an all time low, things do not look that rosy on the debt front.

So does it make sense for a small investor to trust his money with MIPs? It may not be advisable when there is a risk of a downturn in equity markets and the interest rates are low.

Keeping in mind the increased exposure to equities in MIP portfolios, it is prudent to remember that just as the equity class is capable of giving a 20-25 per cent rise in a couple of months, it is equally capable tanking by a similar margin in a similar time span.

The higher equity allocation also means sharper swings in NAV and returns in a volatile market.

While there is a strong case for a conservative investor to invest in MIPs, the risks cannot be ruled out in a volatile market. The best bet would be to stay invested for an adequate period of time, say one or two years, so that one has the chance to offset the losses in case of any short-term downturn.